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A Senator Sees ‘Moral Hazard’ in SBA Loan Program

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Senator Jeff Sessions (R-Ala.) talks to a member of the press on Jan. 6 in Washington — Photograph by Alex Wong/Getty Images

A Republican senator is questioning whether the Small Business Administration’s flagship loan program puts taxpayer money at risk without enough oversight.

Earlier this month, Senator Jeff Sessions of Alabama wrote to new SBA chief Maria Contreras-Sweet, to raise concerns that the agency “has not met the high standards required in providing loan guarantees.” Specifically, the lawmaker says that the agency’s 7(a) program, which backstops private lenders by guaranteeing up to 85 percent of the value of small business loans they make, allows banks to lend with little regard to whether the borrower will be able to pay.

Sessions aimed his epistolary assault at the SBA’s 7(a) loan program, which backed $17.9 billion in general purpose loans in the 12 months ended September 2013. To make his point, Sessions points to reports from the press and the SBA Inspector General that show high default rates on 7(a) loans made to operators of certain franchises, including Quiznos, Cold Stone Creamery, and Huntington Learning Center. Because the government guarantees a big chunk of those loans, “the lender still makes a profit while taxpayers shoulder the cost of the default,” wrote Sessions. “This is what economists call moral hazard.”

In an e-mail, an SBA spokeswoman wrote, “we believe our 7(a) program is strong and these criticisms are unfounded,” pointing out that the program didn’t need subsidies to cover losses.

Sessions’s letter asks Contreras-Sweet to respond to 17 points, with a particularly pointed query aimed at franchise loans: “Please explain whether or not the SBA has excluded certain franchises because of high default rates, and provide the percentage of defaults necessary to exclude a franchise. If the SBA does not exclude franchises based on default rate or otherwise, please state whether the SBA believes it has the authority to do so.”

The queries also suggest that the SBA should shift more risk to banks, and ask the agency to furnish data on banks that have been excluded from SBA programs for making a lot of bad loans. Sessions also targets banks’ practice of selling portions of 7(a) loans to outside investors: “Does the SBA believe that lenders would take more care in issuing loans if guaranteed loans were not transferable?”

Those requests come after Senator Richard Burr (R-N.C.) introduced a bill in December that proposed eliminating the SBA as a stand-alone agency. The plan got attention at the time, partly because it resembled an earlier proposal floated by President Obama, and partly because the White House had allowed the SBA to languish without a permanent leader.

Sessions sits as ranking Republican on the Senate Budget Committee, which helps determine funding for SBA loan programs. His call for a more transparent accounting of SBA lending echoes concerns raised by the agency’s inspector general and by the U.S. Government Accountability Office about oversight at the agency.

The GAO found last September that the SBA has a pattern of starting new programs without gathering “information needed to assess their performance,” auditors wrote. The watchdog was writing specifically about pilot programs. Sessions argues that larger, established programs also merit a closer look.